Effect of Debt Issuance on Stock Valuation

 

Hightower, Inc. plans to announce itwill issue $2.0 million of perpetual debt and use the proceeds to repurchase common
stock. The bonds will sell at par with a coupon rate of 596. Hightower, Inc. is currently an all-equity company worth $7.5 million
with QOo,000 shares of common stock outstanding. After the sale ofthe bonds, the company will maintain the new capital
structure indefinitely. The company currently generates annual pretax earnings of $1.5 million. This level of earnings is
expected to remain constant in perpetuity. The tax rate is 3596.

Prepare a 275-word memo advising the management of Hightower, Inc. on the financial impact, including the following:

-How many shares will the company repurchase as a result ofthe debt issue? How many shares of common stock will remain
after the repurchase?

-What is the required return on the company’s equity after the restructuring?

 

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